The global toy market had an estimated worth of approximately $84 billion in 2012 which included a $20 billion contribution from the U.S. market. The toy industry had an impact of $29 billion on the U.S. economy and sustained approximately 250,000 jobs. According to a research report by Euromonitor, 2012 was another year of expediting global growth in the toy and game industry. The global growth of the toy industry was underpinned by Latin America and Eastern Europe while the U.S. toy industry has become somewhat saturated. This is depicted in the graph below.
October has only just begun and customers have already started planning for the Christmas shopping season. Research firm Accenture has forecasted that shoppers would be spending 11% more than in previous years. Toys will be among the list of top priority purchases for children during the holiday season. The holiday season will boost the sales of toy manufacturers in the upcoming quarter. The U.S. toy industry is an extremely saturated market so international growth would be a key factor in driving the sales of toy manufacturers in the future.
In order to examine the toy industry I have decided to analyze Mattel, Inc. (MAT), which is primed for success in both the United States and abroad. However, the stock has not performed well throughout this period and is trading at 8% below its May high.
With the impending Christmas season, heavy dividend payments and share buybacks are garnering market attention. I believe that company's performance will improve.
The company operates in three segments: North America, International, and American Girl. Second quarter sales of Mattel were up 1% compared to results of the previous year during the same quarter. The increase in company sales were driven by the company's American Girl portfolio. Net income of the company fell by more than 20% in the second quarter, compared to results of the same quarter of the previous year. The decline in the net income of the company is associated with the increase in advertising expenditure and an asset impairment charge of $14 million.
The performance of the Mattel North American segment did not meet expectations and reported a 3% decline in gross sales. The decline in North American sales is the result of the saturated toy market in the US. However, with the impending Christmas season and with Mattel occupying three spaces on the Toy insider top 20 list the company's revenue growth is expected to increase in the coming quarters.
Mattel's international segment sales were up by 4% last year which is more than double the results of the North American segment. In the most recently completed quarter, the company's international segment has continued this positive growth reporting a 4% growth in its sales.
Source: Company's Presentation
The growth in sales is attributed to the 5% increase in the sales of the Latin American region and a 3% growth in the Russian and Eastern European economies. The change in focus towards regions with developing economies is boding well for the company as these markets present strong growth potential.
The Future of Mattel
Mattel benefits greatly from its association with Walt Disney (DIS) and other companies for whom it makes toys under licensing agreements. Mattel's partnership with Disney is time-tested and the companies have enjoyed a working relationship since the 1980's.
In 2009, Disney acquired the comic book franchise Marvel Entertainment for about $4 billion. With this acquisition it acquired popular comic book heroes such as the X-Men and the Avengers. In 2012, Disney acquired the Star Wars franchise for $4 billion. Both of the acquired companies have contracts with Mattel's rival Hasbro (HAS). Marvel's contract with Hasbro will expire in 2017 and Hasbro's Star Wars contract will expire in 2020.
When these contracts expire Mattel will be in a great position to acquire these merchandising contracts from Disney mostly due to their successful business relationship. Hasbro has also acknowledged this in its 2012 annual report.
The threat of "Smart" Devices
Computer, smartphone and tablet usage is increasing among children. According to a report by NPD, more than half of children are using some kind of smart devices. Many people believe that this trend will seriously hurt the toy industry. In an article Dr. Toy (Stevanne Auerbach) argued,
"I just think kids need to get dirty and play in the mud and go out into the woods and play jump rope and have real experiences before Toys become electrified and digitized and not balanced."
In short, Dr. Toy argues that non-electronic toys that encourage physical education provide more benefits than digital toys.
According to another research study conducted by NPD group, more than 50% of parents have stated that smart devices have not had a negative impact on their child. It has also been discovered that children who use smart devices are more likely to request traditional non-electronic toys. This led me to believe that smart devices do not pose a threat to the traditional toy industry.
Mattel has rewarded its shareholders handsomely through profitable dividends and aggressive buybacks. The company has raised its dividend payment by 16% this year compared to last year's payments. It has also returned $119 million through share buyback in the second quarter of 2013 with an increase of $500 million in the company's repurchase program. Mattel provides a dividend yield of 3.4% compared to an S&P yield of around 2%. This dividend yield provides an optimistic outlook for the company's future.
As discussed earlier, Mattel has a rich history of returned dividends. Due to its persistent dividend history, the dividend discount model is the most appropriate method to calculate the company's fair value. I have made certain assumptions in order to estimate the fair value of the company using the DDM. I have calculated an 11.14% growth rate by assigning different weights to the analyst consensus growth estimate, the historical growth rate, the internal growth rate and the sustainable growth rate. After five years, the growth rate will decrease by 2.50% over the next five years from fiscal year 2013 to fiscal year 2017.
Assuming a market rate of return of 12.28% (calculated using the five year S&P average) and a risk free rate of 2.63% of the 10-year Treasury bond yield, the required rate of return is calculated to be 9.26%. This results in a price target of $48.26 a share with an upside potential of 19.47%.
The sensitivity analysis shows the company's valuation price with respect to the expected growth rate and required rate of return. The table shows that in the best case scenario of a 13.14% expected growth rate and an 8.91% required rate of return, the stock presents an upside potential of 41.84% with a price of $57.29 per share. On the other hand, in the case of a 9.14% growth rate and a 9.96% required rate of return, a downside of 4.12% is incurred with a stock price of $38.72 a share. The sensitivity analysis shows that the stock provides a stronger advantage in the case of volatility with respect to growth and cost of equity.
The impending holiday season will boost the sale of the toy industry. Though the U.S. toy market is somewhat saturated, the toy industry can expect growth to be derived from international sales. Mattel is very well positioned to reap the benefits of international sales since it has been experiencing an increase in sales from its international operations since last year. The acquisitions made by Disney have placed Mattel in a strategic position since Disney has always favoured Mattel as its toy manufacturer due to their long-standing business relationship. The expiration of Marvel and Star Wars' contracts with Hasbro would bode well for Mattel if the company is able to close these deals with Disney.
Mattel is currently trading at $40.39 while its intrinsic value, calculated from the dividend discount model, is $48.26 with an upside potential of around 19.47%. Keeping in mind my analysis and the company valuation, Mattel appears to be an attractive investment opportunity. I would recommend buying the stock.